Opinion: Is 3% growth the ‘new normal’?

It wasn’t too long ago that the economic establishment, including policy makers at the Federal Reserve, reluctantly came around to the view that 2% real growth was as good as it gets for today’s economy.

With solid fourth-quarter economic data raising the prospect of a third consecutive quarter of 3% growth for the first time since 2004-2005, is it unrealistic to think that 3% may be the new normal? And if so, what’s changed to make that leap from the 2.1% post-recession average growth rate?

Manufacturing productivity has been notably weak during this expansion. It increased a scant 0.3% in the last four quarters.

“The dynamics of capital were affected by the Great Recession,” said John Fernald, professor of economics at INSEAD, outside of Paris. “Businesses had lots of capital, capacity, coming out of the recession, and no demand.”

That actually let to capital “shallowing,” the opposite of capital deepening, since 2010, Fernald says, and helps explain the dismal increase (an average of 0.8%) in output per hour worked since then.

Maybe that’s about to change. After all, the U.S. stock market is positively giddy over the prospect of slashing the corporate income-tax rate from 35% to 20% and at least five years of immediate expensing of capital investment, as provided for in both House and Senate versions of the tax bill. Small-business optimism soared to a 34-year high in November, according to the latest monthly survey by the National Federation of Independent Business. Small business owners cited a lack of qualified workers as their No. 2 problem, right behind taxes.

That sounds like a formula for capital investment, which has been a missing link in the current expansion for the reasons Fernald explained. He expects to see some pick-up in capex and a modest acceleration in productivity growth, perhaps “back to the 1.5% of the Reagan or Carter years,” but nothing like the 1990’s surge.

Productivity growth derives from human capital — labor — as well as physical capital. Fernald isn’t optimistic about any sustained boost from labor quality, which includes education and skills, as lower skilled workers, laid off during the recession, are drawn back into the labor force and highly skilled baby boomers retire en masse. (The third contributor to productivity growth, total factor productivity, is a residual and reflects how efficiently labor and capital inputs are utilized.)

This wouldn’t be the first time that innovations in technology take time to mesh with one another and exploit their synergies to raise the nation’s productive potential. It happened in the 1990s, well after Nobel laureate Robert Solow made his observation (in 1987) that the computer age was everywhere apparent “except in the productivity statistics.”

After a slump in productivity to 1.5% from the mid-1970s to the mid-1990s, the growth rate almost doubled from 1995 to 2004. Experts are still debating whether the slump represents the exception to the rule or the long-term trend.

Today technology is everywhere, and consumers can’t take their eyes off it: their smartphones, in particular. More and more research is finding that much of today’s consumer technology is less productivity-enhancing than mentally distracting, diverting us from more productive endeavors. (How many times did you check Twitter while you were reading this column?)

Which brings us to the Fed and its views on the new normal.

The idea that tax cuts are going to jolt the economy into a 3%, even 4%, growth cycle, as President Donald Trump and some of his associates claim, is unrealistic, to say the least. Given the Fed’s reliance on the Phillips Curve, or a presumed inverse relationship between unemployment and inflation, policy makers are unlikely to wait passively for any supply-side effects to accommodate any sustained increase in demand.

With its official projections for potential GDP growth (1.8%) and full employment (4.6% versus today’s 4.1%) realized, the Fed has outlined a plan for a gradual normalization of the federal funds rate and a drawdown of its balance sheet, even though some policy makers are concerned about below-target inflation for the last six years.

The Fed has all but announced another 25 basis-point increase in its benchmark rate to a range 1.25% to 1.5% at the conclusion of its meeting on Wednesday. Its most recent summary of economic projections from September targets three quarter-point rate increases next year.

Fed officials have said they will not incorporate any expected impact of a tax cut until a bill is finalized and passed. In terms of drawing any conclusions about a shift in trend productivity, and hence economic growth, patience is warranted, Fernald said.

“It wasn’t until 1999 that people bought into the new economy after big data revisions,” he said.

Similarly, it wasn’t until well after the recession ended in 2009 that economists came to accept that the productivity trend had changed.

Alas, hindsight is only 20/20 with long and variable lags.

Caroline
Baum

Caroline Baum is an award-winning journalist who has been writing about the U.S. economy for three decades.

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